There are several charges associated with a loan be it of any kind personal loan, home loan or car loan. Amongst the various charges, the interest rate is the primary component that every loan applicant checks before getting a loan. Even though everyone checks the interest rate charged, there is some calculation involved that determines the significant amount that needs to be paid monthly.
Amortization is a concept that explains the reduction of a debt over the period by making regular payments. The monthly payments will include both the interest rate amount and the principal amount. The percentage of the interest amount keeps getting down towards the end of the tenure.
An amortization schedule refers to the loan schedule with a breakdown of the principal amount clearance that includes the monthly payment to be made, the percentage of interest rate amount in the payment.
There is a formula to calculate the first-month installment that is
I = P[r(1+r)^n/(((1+r)^n)-1)]
I = Monthly Installment Amount
P = Principal Amount
r = Interest rate (per month)
n = tenure of the loan(in months)
For example, consider a loan amount of AED 5000 for a tenure of 1 year and an interest rate of 10%(per month) is charged.
As per the tenure of 1 year i.e. 12 months and 10% interest rate on loan amount AED 5000,
The interest rate levied monthly would be (10%/12) = 0.00833% of the outstanding loan balance
I = 5000[ 0.0083(1+0.0083)^12/ (((1+0.0083)^12)-1)] = 440
Therefore the monthly installment would be AED 440, where 0.008% of the outstanding principal amount will be the interest amount and the rest will be reduced from the outstanding principal balance.
From 2nd month, the percentage of the interest amount in the monthly installment keeps getting decreased and the percentage of loan amount installment increases.
|Period||Monthly Installment Amount||Monthly Interest Amount||Principal Amount Installment||Outstanding Loan Balance|
|1||AED 440||AED 42||AED 398||AED 4,602|
|2||AED 440||AED 38||AED 401||AED 4,201|
|3||AED 440||AED 35||AED 405||AED 3,796|
|4||AED 440||AED 32||AED 408||AED 3,388|
|5||AED 440||AED 28||AED 411||AED 2,977|
|6||AED 440||AED 25||AED 415||AED 2,562|
|7||AED 440||AED 21||AED 418||AED 2,144|
|8||AED 440||AED 18||AED 422||AED 1,722|
|9||AED 440||AED 14||AED 425||AED 1,297|
|10||AED 440||AED 11||AED 429||AED 868|
|11||AED 440||AED 7||AED 432||AED 436|
|12||AED 440||AED 4||AED 436||AED 0|
By the end of the 12th month, the loan will be cleared. Towards the end, only AED 4 is the interest amount paid. This total schedule/ table of the monthly payments is called an amortization schedule.
When the loan holder makes any additional payments other than the monthly installment amount or make a partial payment, it will reduce the share of interest amount in the monthly installment and reduce the tenure of the loan, certainly. In simple terms, the amortization schedule will make the loan holder understand the monthly payments of the loan and get an idea of how much interest amount will be paid totally for the loan taken.